By Lauren Tara LaCapra
NEW YORK, Dec 4 (Reuters) – Just a few years ago, Morgan
Stanley lacked the expertise, infrastructure or desire to
do a lot of lending, but today it is making a big push into
loans to bridge a profit gap with rivals.
Morgan Stanley’s brokerage business historically focused on
helping clients invest in stocks and bonds, leaving lending to
competitors like Citigroup with bigger retail banking
operations.
But lending is a key source of revenue in the brokerage
business now. Interest rates are near zero, which weighs on the
returns that brokerages can earn from investing client deposits
in securities. By making more loans instead, Morgan Stanley
could generate an extra $300 million of annual profit by one
analyst’s estimate.
Morgan Stanley is behind its competitors. For every dollar
of client deposits, Morgan Stanley makes just 55 cents of loans,
far less than the 70 to 80 cents that rivals banks make in their
brokerage businesses. Its profit margins are weaker than other
major brokerages.
To expand its lending book, it has been hiring hundreds of
bankers, underwriters and back-office staff to help push
everything from mortgages to stock loans. It is also marketing
its loan offerings to clients more aggressively, and changing
the bonus structure to encourage brokers to lend more.
The bank wants to lend 70 percent of its deposits by 2015,
and 90 percent over the long term. Morgan Stanley’s management
wants to build the bank’s loans across investment banking and
trading as well, but wealth management is a big part of the
buildout.
“We want to be able to provide good advice on both sides of
the balance sheet – not just investments but also lending,” said
Shelley O’Connor, chief executive of Morgan Stanley’s private
bank. “You want to be the quarterback for what the client needs
financially.”
O’Connor and Eric Heaton, who is president of both the
private bank and Morgan Stanley Bank NA, are tasked with getting
the lending operation into full swing, and recently spoke with
Reuters about their plans.
The wealth division has become much more important to Morgan
Stanley under the leadership of Chief Executive James Gorman. In
the wake of the financial crisis, Morgan Stanley agreed to buy
Citigroup’s Smith Barney business over time and merge it with
its own wealth management unit, a process that began in 2009 and
is slated to end in 2015.
Wealth now accounts for more than half of Morgan Stanley’s
revenue and its pretax profit margin rose to 18 percent in the
first nine months of this year, compared with 5 percent for all
of 2009.
Despite that progress, Morgan Stanley Wealth Management is
still underperforming major rivals. Bank of America’s wealth
business has delivered a pretax margin of 26 percent so far this
year, while Wells Fargo & Co’s Wells Fargo Advisors is
at 20 percent and Swiss rival UBS AG reported a 31
percent pretax margin year-to-date.
Analysts say a big part of that gap pertains to Morgan
Stanley’s newcomer status in lending. UBS analyst Brennan Hawken
estimates Morgan Stanley will take in another $300 million in
annual pretax income if it can lend out 70 percent of its
deposits.
SWEETER BONUSES
Lending has become a significant component of Morgan Stanley
Wealth Management’s annual “growth” bonuses, which reward
advisers for growing assets, loan balances and overall revenue.
Under the new plan for 2014, advisers can earn up to $202,500
for loan growth, up from $127,500 in 2013.
Advisors are also rewarded on a staggered scale for
individual loans. For example, they can earn 50 basis points for
the first three mortgages they initiate, then 65 basis points
for the next four to six mortgages, and 75 basis points for
mortgages beyond that. In dollar terms, that equates to $2,500,
$3,250 and $3,750 for each $500,000 worth of mortgage debt,
respectively.
O’Connor and Heaton are hoping the sweeter lending bonuses
will get more advisers to warm to lending. A little more than
half of the firm’s 16,500 financial advisers have loaned money
to a client. The executives aim to get that figure to somewhere
in the high-70s to mid-80s over the next two years.
O’Connor and Heaton have so far hired 160 private bankers to
work with advisers on growing their loan books, along with staff
to handle underwriting, risk-management and back-office
functions. They plan to add more bankers to the payroll in
coming years as the lending operation grows, O’Connor said.
The bank is also working to get more clients to think of
Morgan Stanley as a lender. Only 5 percent of Morgan Stanley’s
wealth clients have a loan from the bank. O’Connor and Heaton
want to double that figure, and will early next year roll out
new applications for mobile banking, bill payments and account
management.
Brad Hintz, an analyst with Bernstein Research, said Wall
Street banks have tried to gain a stronger foothold in lending
many times to disastrous ends because brokers and investment
bankers are incentivized to generate income by lending but do
not have appropriate risk-management protocol in place. He cited
Merrill Lynch’s push into small-business lending in the early
2000s, which led to big losses when Gorman was a top executive
there.
“This may be a remake of a movie we saw once before,” said
Hintz.
Morgan Stanley executives say they are not allowing bankers
and brokers to issue loans willy-nilly to boost returns.
Chief Financial Officer Ruth Porat said in September that
loans must adhere to “board-level underwriting criteria” and
Heaton said that all loans are priced so that Morgan Stanley
earns returns in excess of its cost of capital, and is wary
about taking on duration risk for long-term loans.
Morgan Stanley spokesman James Wiggins said the losses at
Merrill Lynch stemmed from loans made to small-business owners
outside of the firm’s existing client base, and were
concentrated among building contractors. “We want to be very
clear that this is NOT the kind of lending we are doing at MS
Wealth Management,” Wiggins said in an email.
TWO DAYS FOR A LOAN
Most of Morgan Stanley Wealth Management’s loans come from
securities-based lending, which uses clients’ investment
portfolios as collateral. If a client fails to pay, Morgan
Stanley can seize and liquidate the assets, though executives
said that rarely happens.
This type of lending can also deliver new assets. One
adviser recalled a recent instance in which Morgan Stanley beat
out JPMorgan Chase & Co for a $60 million
securities-based loan by offering a better rate. The client had
to deliver more than $100 million worth of assets for the loan,
because Morgan Stanley Wealth Management typically lends against
roughly 50 percent of a client’s holdings.
While O’Connor deals with loans to wealth clients and other
banking services, Heaton also oversees Morgan Stanley’s
expansion of loans to institutional securities clients.
Underwriting staff must sign off on any loan before it is
approved. Those staff report into the risk-management division
headed by Chief Risk Officer Keishi Hotsuki.
“We’ve got support from the top of the house to continue
doing this in a measured way,” said Heaton. “We’re not racing to
get it all out the door next year.”
(Editing by Tiffany Wu and Tim Dobbyn)
